February 2011 Archives
What Are Subprime Mortgage Loans?
Subprime lending refers to the extension of credit to higher-risk borrowers, a practice also commonly referred to as “BC” or “nonconforming” credit. Loans to subprime borrowers serve communities that may have been underserved by other lenders in the past. In recent years, subprime mortgage lending has grown dramatically, with over 90% of all subprime mortgage loans made in or after 1993. By the end of 1996, the total value of outstanding subprime mortgage loans exceeded 350 billion. In 1997 alone, subprime lenders originated over 125 billion in home equity loans. Subprime loans have become a significant and growing part of the home equity market. Subprime originations constituted 11.5% of the total home equity lending market in 1996; by the first half of 1997, they had grown to 15.5% of this market. At the same time, the composition of companies involved in the subprime market is evolving. One of the dramatic changes in this market has been the growth in subprime mortgage lending by large corporations that operate nationwide.
The subprime mortgage market has flourished because such lending has been profitable, demand from borrowers has increased, and secondary market opportunities are growing. Lenders typically price subprime loans to consumers at rates of interest and fees higher than conventional loans. Higher rates and points can be appropriate where greater credit risks are involved, as is often the case with subprime loans. Critics assert, however, that the interest rates and fees charged by some subprime lenders are excessive, and much higher than necessary to cover increased risks, particularly since these loans are secured by the value of a home. Some attribute lenders’ high rates on first mortgages in part to federal deregulation of certain state interest rate ceilings in 1980.
The relatively high profit margins in the subprime mortgage industry have fueled demand in the secondary market from investors seeking higher-yielding securitized assets, especially in an environment of generally low interest rates. In 1996, the subprime mortgage sector issued over 38 billion in securities, the largest increase in securitizations for any lending industry sector in that year. The secondary market’s expansion has, in turn, helped to sustain growth in the industry by enabling lenders to raise funds on the open market to expand their subprime lending activities. Freddie Mac, one of the primary government-sponsored enterprises involved in the purchase of mortgages, recently announced plans to enter the secondary market in subprime loans by purchasing significant numbers of “A minus” subprime mortgages by 1998 and the higher-risk “B and C” loans by 1999.
The market for subprime loans is expected to continue growing. Credit card delinquencies are rising and personal bankruptcies are at record levels, which negatively affect borrowers’ credit histories, pushing more consumers into higher risk categories. Meanwhile, consumer spending continues to be strong. Together, these factors increase the market for subprime loans. In addition, more borrowers generally may be seeking home equity loans due to the change in the tax code limiting allowable interest deductions to those on a first mortgage.
Using Points To Cut Your Interest Rate
The general mantra in the real estate world is you want to avoid paying points when obtaining a mortgage. As with most assumptions, this is not always true.
Using Points To Cut Your Interest Rate
When discussing mortgages, it is important to understand what points are. Points are essentially an upfront cost you pay a lender in exchange for getting the loan in question. The better your financial profile credit score, wages, down payment amount the fewer points you have to pay, if any. That being said, you may actually want to demand points in certain situations.
Points and interest rates have a unique relationship in mortgages. Generally, the more points you pay, the lower your interest rate. This is not always the case in bad credit situations, but it is a generally accepted fact for most bowers. You can use this relationship to your advantage.
Regardless of how many points you pay on a loan, the cost will never remotely approach the amount of interest you pay over the life of the loan. If you intend to live in the property in question for a long time, you should make an almighty effort to cut your interest rate as low as possible. This is where you will save the most money. This is also where points come in.
If you are cash rich when you buy the property, you can buy down your interest rate by agreeing to pay the lender a significant number of points. The key is to find out from the lender how much they will reduce the interest rate per point paid. You want this in writing! Once you have it, use a mortgage calculator to see how much money the various lower interest rates will save you over time. Also, see how much you monthly payment is reduced. Once you have the numbers, compare them to the total cost of paying additional points and make your decision.
Contrary to popular opinion and marketing ads, points do not represent the evil side of the mortgage industry. Use them wisely and you can save hundreds of thousands of pounds over the life of a loan.
Using Mortgage Interest as an Itemized Deduction
What is mortgage interest? It is any interest you pay on a secured loan when you bought your first or second home. The loans include the mortgage to buy your home, a second mortgage, a line of credit or a home equity loan. The loan must be secured debt or it will be considered a personal loan and the interest is not deductible.
For the average consumer who has managed to acquire credit card debt, car loans, and various other small debts, is the mortgage interest, especially with an interest only loan an answer to mortgage interest deductions and the elimination of non-deductible interest?
What options does the average consumer have in accommodating the tax need in relation to the housing need? What about the interest only loan option on a new house mortgage? Todays housing and mortgage market has seen a tremendous growth in mortgage packages, variety and amount. The mortgage interest deductible on the interest only loan option, once thought to have gone the way of the Edsel automobile, is back today and in use by the masses. The mortgage market has seen an unbelievable increase in the interest only loans from just a mere sliver of the market a few years ago, to around 25% of the market share today. Thats huge growth, especially when you talk less than five years to experience that growth.
What benefit does the mortgage interest (especially the interest only loan) bring to the table, and does this benefit the homeowner as a taxpayer? This is one question the mortgage lender probably wont be able to answer for you, and one you probably wont think to ask. But you should, because its one question that can make a difference to you and to your federal tax return and the amount of the mortgage interest that will actually provide you with a federal income tax deduction. A mortgage interest deduction is one of the best financial reasons to purchase a home. Who gets the deduction? You do, if you are the primary borrower, legally obligated to pay the debt and actually make the payments. If you are married and both of you signed the loan then both of you are the primary borrowers.
The interest only loan and the amount of interest you can deduct on your income tax return are one and the same if your income levels are low enough; the concern for the average consumer is the total pound value they get to take off their tax return. Quite often, the deductions for the consumer arent enough to contribute to the bottom line, because the income level the percentage of deductible interest is calculated on is simply too high. Higher pound amounts in interest will usually mean a greater possibility of a greater deduction. There can be limits to the tax deduction. Your tax deduction is limited if all mortgages on your home are either more than the fair market value of your home or more than one million pounds (500,000 if married and filing separately)
The greater deduction would be the only advantage to the interest only loan as far as the taxpayer is concerned, unless of course, they use the money saved from the interest only loan to fund a 401k, an IRA, or an MSA (thats a topic for a completely different paper). The mortgage interest and especially the interest only loan is sold to the consumer as a way to afford more house, pay off credit card debt, or provide a means to fund a savings of some kind, and if thats true, it can be used for that purpose. And if youre considering paying off those high interest credit cards, the mortgage interest youre charged on the interest only loan is fully tax deductible, while the credit cards are not; a word of caution, however, make sure you dont turn around and use those credit cards again, putting yourself right back where you started from, just with a bigger interest payment and less house equity.
Why has the market experienced such growth? Its not totally related to the income tax benefit; the home mortgages of today satisfy a common desire for the consumer: instant gratification of bigger and better. Such is the case when its time to make those needed repairs, or house expansion. A second mortgage makes it possible to retain the same monthly mortgage payment, and still pull a lot of equity out of your home. This may sound like the ultimate solution, but is it really? It also adds to the amount of interest an individual can deduct at the end of the year; and if income levels are growing, the interest expense must grow in order to keep up. Now, this is a somewhat skewed way of looking at the benefit of a mortgage, but it figures right into the same scheme as the elimination of credit card debt and saving for 401(k) s as a valid reason to borrow money against your home.
Remember that your home mortgage must be a secured loan from your main home or second home. No deduction can be made for a mortgage from a third home, fourth home and so on. The mortgage and the resulting interest are great tools, when used by the right people, in the right situation. For the average consumer and long-term homeowner, unless you think a better deduction on your tax return is worth the forfeiture of equity in your home, youd better think twice before re-financing with a second mortgage that generates more interest, but less equity.